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Soft Patch to Keep Bank of Canada on Sidelines: Decision-Day Guide

(Bloomberg) -- Canada’s recent dip into an economic soft patch will keep the country’s central bank from raising interest rates for a second straight decision Wednesday, with investors betting it may even be done with hiking altogether.

The Bank of Canada is likely to remain on hold for at least a few months as the country copes with turmoil in the oil sector and policy makers gauge the impact of volatility in financial markets. After that, views diverge.

Economists expect hikes to resume later this year -- with one or two more increases-- given the nation’s fundamentals remain strong despite recent headwinds. Markets are less sanguine, focusing more on the deteriorating global economic outlook and trade risks between the U.S. and China. Swaps trading suggests investors believe the Bank of Canada’s normalization may already have come to an end, after five hikes since the middle of 2017.

“The pendulum in the market often swings more than the underlying facts on the ground,” Avery Shenfeld, chief economist at CIBC World Markets, said by phone. “We’re still expecting a hike or two in 2019,” though “it’s going to really depend on what sort of recovery we get in oil prices and when we get it.”

All but one of 18 economists surveyed by Bloomberg expect the central bank to keep its benchmark rate at 1.75 percent in a decision at 10 a.m. in Ottawa. Markets are pricing in zero chance of an increase. The Bank of Canada will also release its quarterly economic forecasts Wednesday, followed by a press conference from Governor Stephen Poloz.

What’s certain is the Bank of Canada will need to revise down its projections for growth, at least for this year, thanks to weaker oil prices and transport bottlenecks that have prompted the Alberta government to implement temporary production cuts. In its October forecasts, the central bank estimated growth of 2.1 percent in 2019 -- which now looks on the high side.

Economists see Canadian growth sliding closer to 1 percent on an annualized basis for a few months, before bouncing back once Alberta’s output cuts are lifted. After that, the pace of the expansion should return to near its recent trend of 2 percent for the rest of the year.

‘Solid Footing’

Recent data have been promising. Canada’s economy continues to produce enough jobs to keep the unemployment rate at historic lows, and businesses remain upbeat about investment and hiring plans. Even oil prices have shown a bit of a comeback in recent days, giving a lift to the Canadian dollar to start the year.

“We have entered a slow patch, but the economy is on solid footing,” said Josh Nye, an economist at RBC Capital Markets, which is expecting the central bank to increase rates twice this year.

Still, there’s enough concern to curb the central bank’s enthusiasm for higher rates and even in the best case Poloz is probably already near the end of his hiking cycle. For one, signs have begun to emerge that higher interest rates are slowing consumption and the housing market. There is also new evidence suggesting the economy had more slack in recent years than previously thought.

Plus, with markets also pricing in a rate pause from the Federal Reserve, the Canadian central bank may be reluctant to press ahead with higher interest rates for fear of driving up the country’s currency.

But Poloz isn’t sounding like someone who has given up on rate increases. The central banker told CTV News last month that interest rates should eventually move toward a neutral range of 2.5 percent to 3.5 percent given the economy is operating near capacity, unemployment is at four-decade lows, and inflation is at the central bank’s 2 percent target.

“Getting there, it’s a journey and we expect over time to get there. But it can be interrupted or it could be sped up, depending on how the economic data evolve,” Poloz said.